An unprecedented spike in the prices of natural gas and other raw materials is set to inflate the Union government’s fertiliser subsidy bill by ~62% — or Rs 50,000 crore — to Rs 130,000 crore this fiscal, compared with a budgeted Rs 79,530 crore. This would be despite the sales volume of fertilisers declining ~10% on-year.

To encourage farmers to use fertilisers for better crop yield, the government keeps their retail sales price (RSP) significantly lower than the market rate, and reimburses the difference to manufacturers through subsidy payments (see chart 1 in annexure).

However, for long, government provisioning for such subsidy payments have been inadequate, which led to regular build-up of arrears that posed a challenge to the sector. But last fiscal, the government cleared the arrears through an additional disbursement of Rs 62,638 crore.

Now rising input costs have become a bother. Crisil Ratings expects the price of natural gas — the feedstock that accounts for 75-80% of the total cost of production of urea plants — to rise over 50% this fiscal. For non-urea fertilisers, prices of key raw materials such as phosphoric acid and ammonia are already up 40-60% over last fiscal (see chart 2 in annexure).

All this will have to be absorbed by the government. Consequently, Crisil Ratings estimates that the government’s subsidy burden will increase by ~Rs 50,000 crore over what has been budgeted for this fiscal.

Says Nitesh Jain, Director, Crisil Ratings Ltd, “The government has been proactive given the strategic importance of the fertiliser sector. It has already announced an additional subsidy of Rs 21,328 crore (Rs 14,775 crore in May 2021 and Rs 6,553 crore in October 2021) for non-urea fertilisers. Despite this, there will likely be a shortfall of ~Rs 30,000 crore, largely for urea.”

But there is a partial offset available this fiscal because sales volume of fertilisers is expected to decline a significant 8-10%. Last fiscal, it had risen 8% to an all-time high of 66 million tonne (see chart 3 in annexure).

Sales have been affected this time because the spatial distribution of the southwest monsoon has been erratic. While the cumulative rainfall this season was 99% of the long period average (LPA), its distribution was uneven — 110% in June, 93% in July, 76% in August and 135% in September — which affected sowing.

Additionally, the high-base effect created by last fiscal’s sales volume, and limited availability of fertilisers in the international market will also have a bearing.

But domestic production won’t be materially impacted because India imports 30% of its fertiliser needs and the lower sales volume will also mean fewer imports.

As for profitability, urea makers are unlikely to be affected because the higher cost of gas is a pass-through with the government fixing the RSP. For non-urea fertiliser makers, while the selling price is not fixed, the government pays subsidy as per the Nutrient-Based Subsidy Scheme rates.

Credit profiles in the sector will also be influenced by the working capital cycle.

Says Ankit Kedia, Associate Director, Crisil Ratings Ltd, “The working capital cycle of fertiliser manufacturers is a function of adequacy of the subsidy budget and timeliness of disbursements. The additional subsidy disbursed this fiscal has markedly improved debtor days to ~60 as of March 2021¹ from ~200 as of March 2020. Also, there has been no major increase in their working capital borrowings as of September 2021, which indicates subsidy disbursements have been regular. But any fresh shortfall or delay in disbursement can stretch working capital cycles, so will bear watching.”

¹ Includes 7 companies which represent ~60% of the total fertiliser sales volume in fiscal 2021